Federal Insurance Contributions Act

A statute in the United States called the Federal Insurance Contributions Act (FICA) established payroll taxes to pay for the Social Security and Medicare programmes. The hospital insurance tax, often known as Medicare taxes, and the old-age, survivors, and disability insurance taxes (commonly referred to as Social Security taxes) make up the taxes under the Federal Insurance Contributions Act (FICA). There are several rates for these taxes. The taxes are computed as a percentage of the employee's subject wages. FICA mandates that employers take the proper amount out of each employee's paycheck and transmit it to the government.. The consequences of non-compliance might include severe penalties.

History of Federal Insurance Contributions Act (FICA)

The Federal Insurance Contributions Act, also known as FICA, was enacted by the US Congress in 1935. Its goal was to raise money for the newly created Social Security program, which was put into place by President Franklin D. Roosevelt's government the same year.

Roosevelt felt that the FICA taxes paid by all working Americans would go straight to them. He didn't want the retirement, disability, or death benefits for them to be reliant on tax dollars from the federal government. He was concerned that the money would be taken by politicians for their personal use.

With the passage of Medicare by President Lyndon B. Johnson in 1965, the payroll tax was imposed to pay for healthcare benefits.

Contributions to FICA are required. Although the rate has mainly been stable since 1990, it can be set annually. Every year, the cap is changed based on the National Average Wage Index.

The Self-Employed Contributions Act (SECA)

The self-employed are responsible for paying both the employer and employee components of Social Security and Medicare taxes under SECA. For instance, as a sole entrepreneur, you would be required to contribute 2.9% of your income to Medicare and 12.4% of your income to Social Security.

Moreover, you'd pay the additional Medicare tax of 0.9% on self-employment income over the threshold amount.

Although self-employed individuals pay more taxes than employees, they do have a tax benefit as they can deduct the employer's portion (half) as a business expense.

How To Calculate FICA

Example 1

By 2023, an employee earning $50,000 will be paying a total of $3,825 towards FICA, comprising $725 for Medicare tax and $3,100 for Social Security tax.

How it's calculated:

Calculating for an employee earning $50,000, the Social Security tax amounts to $3,100 which is obtained by multiplying $50,000 by the employee rate of 6.2%.

Meanwhile, the Medicare tax is $725 which is computed by multiplying $50,000 by the employee rate of 1.45%.

Total FICA = $3,825 ($3,100 + $725)

Example 2

FICA contributions for a worker making $250,000 and filing alone in 2023 will be $13,282.40. In terms of Social Security and Medicare taxes, that amounts to $9,932.40 and $3,350, respectively. Due to the fact that the employer is exempt from paying the additional 0.9% Medicare tax on the first $50,000 over the $200,000 threshold, the wage earner's employer would make a little savings.

How it's calculated:

For Social Security tax, based on the wage base limit of $160,200 and the employee rate of 6.2%, the amount is $9,932.40.

For Medicare tax, using the employee rate of 1.45% and an income of $200,000, the amount is $2,900.

In addition, an extra Medicare tax of 0.9% is applied to income above a certain threshold. Based on an income of $50,000, the additional Medicare tax is $450 which is obtained by multiplying $50,000 by the total rate of 0.9%.

Total Medicare taxes = $3,350 ($2,900 + $450)

Total FICA = $13,282.40 ($9,932.40 + $3,350)

Key Takeaways

  1. Individuals' FICA contributions finance present benefits and establish future ones that will be due to them.
  2. The deduction for FICA contributions is made from a wage earner's gross pay, and the deducted amount is based on their gross wages.
  3. FICA taxes paid by employees are matched by their employers.
  4. The FICA taxes must be paid by wage earners without exception.
  5. The Social Security programmes that pay payments to retirees, children and surviving spouses, and the disabled have been supported by FICA since the 1930s.
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